Correcting Robert Samuelson on Japan and Deflation

Monday, 12 March 2012 04:21

Robert Samuelson rightly calls attention to the decision of Japan's central bank to target a 1.0 percent inflation rate, although he doesn't get a few of the key points right. First, this decision, if accurately described, will provide a huge test of an economic policy first proposed by Paul Krugman and later endorsed by Federal Reserve Board Chairman Ben Bernanke when he was still a professor at Princeton.

The question is whether by setting a higher inflation target, a central bank can bring about a set of self-fulfilling expectations that actually produce this higher rate of inflation. If Japan's central bank is actually committed to this policy, and it proves successful, it would have enormous implications for the conduct of monetary policy elsewhere.

For example, it would mean that if the United States wanted to run 3-4 percent inflation to reduce debt burdens and lower real interest rates, the Fed would have the power to bring this about [thanks JMiner]. That would make a huge difference for the pace of the recovery.

Samuelson gets some of the other aspects of this issue wrong. For example, he says that Japan's deflation is a problem in part because falling prices cause people to delay purchases since items will be cheaper in the future. This would be true for rapid rates of deflation, but Japan's deflation has almost always been less than 1.0 percent a year. In 2011 its inflation rate was -0.2 percent. This means that if someone was considering buying a $20,000 car, they could save $40 by waiting a year. It is unlikely that this rate of deflation affected the timing of many purchases to any significant extent.

The main problem with deflation is simply that the inflation rate is too low. In a weak economy it would be desirable to have a negative real interest rate, however nominal interest rates can't go below zero. (The real interest rate is equal to the nominal interest rate minus the inflation rate.) This means that the lower inflation rate, the higher the real interest rate. In this respect, a decline in the inflation rate from 0.5 percent to -0.5 percent is no worse than a decline in the inflation rate from 1.5 percent to 0.5 percent.

Samuelson also wrongly claims that a fall in the value of yen is one desired possible outcome from a higher rate of inflation since it would increase net exports. This does not follow. If prices in Japan rise by 1.0 percent and the value of the yen falls by 1.0 percent then the competitiveness of Japan's products will remain the same. Japan's competitiveness would only improve if the value of the currency fell by more than the rise in the inflation rate. (What actually matters is relative inflation rates, but this is the basic point.)

Finally, Samuelson includes some of his standard misplaced demographic warnings. He tells readers that Japan is suffering from a declining population. It is difficult to see this as a cause of suffering in Japan at the moment. Japan is a densely populated island where land is extremely expensive.

A decline in population will help to reduce this crowding, leading to higher living standards. Also, the problem of a declining population is supposed to be a shortage of workers. Japan does not have this problem as, by all accounts, it continues to suffer from an underemployed workforce.

Finally, Samuelson warns that Japan, like the United States, suffers from a severr debt problem. Samuelson notes that Japan's ratio of debt to GDP is well over 200 percent. This is more than twice as high as the projected debt to GDP ratio for the United States in a decade.

Japan can still borrow long-term in financial markets for around 1.0 percent. Its interest burden is around 1.5 percent of GDP. (The net burden is probably around half of this, since much of this interest is paid to Japan's central bank, which then refunds the money to the Treasury.) If there is a cautionary tale for the United States with Japan's debt, it is difficult to see what it is.

Concerning Fed inflation related actions mentioned in your first three paragraphs, do you believe the Board would purposely delay them until after the election?

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Aggregate population and GDP are good for property ownerswritten by Blissex,
March 12, 2012 1:21

«Japan is a densely populated island where land is extremely expensive.

A decline in population will help to reduce this crowding, leading to higher living standards.»

Here you are implicitly making the very good point that policy goals should be about median or at least average per-person living standards, rather than aggregate GDP.

But from the point of view of owners of large properties, it is better to have larger aggregate population and/or GDP than higher per-person living standards.

Because the value of a positional good or property, for example a brand or a business in a city, depend directly on demand, which is higher the more people there is, and inversely on labor supply, which is greater the more people there are.

If you own a restaurant in a city, and the population of the city doubles, the value of the restaurant probably doubles as well, because its position in a booming city means more customers, giving the owner pricing power, and more job applicants, reducing the pricing power of existing staff too.

The same for example the owners of a brand like Coca-Cola: the value of the brand is much higher in a USA with 400m people than in one with 100m people, even if perhaps in the latter case each would have a much better living standard.

Dean, Didn't you meant to write "lower" real interest rates in the following,"For example, it would mean that if the United States wanted to run 3-4 percent inflation to reduce debt burdens and raise real interest rates, the Fed would have the power to bring this about.

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...written by red,
March 12, 2012 9:37

The swedish central bank had a negative nominal interest rate in 2009 and a carrying tax would make nominal negative interest rates attractive.

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Mrwritten by ok,
March 12, 2012 11:51

To those who like to discuss economics (ie angels and pin heads), let's get our terms straight.

Inflation: Growth in the supply of currency (ie debasement) along with suppressed interest rates (the price/cost of money)

Consequences of Inflation:

Rising prices as more (lower value) money chases goods and services. Lost purchasing power to all but the wealthy (inflation tax) as income fails to keep up. Lower rates mean decreased savings and thereby real capital for productive investment and production. Mis-allocation of capital due to false (top down rather than bottom up) pricing relative to real market supply and demand. Said capital wasted in unproductive use - limiting real economic growth. Soviet style central planning did no worse than what central banking does with its self-serving monopoly control of money supply and interest rates. Fewer jobs as the economy contracts. A wealth transfer from the public to the banks and their friends with first dibs on the new “money.” Sustainability of the debt paradigm whereby the cost to service debt is kept artificially low and overall indebtedness is increased. Eventual default on the debt means the banks can take productive assets on the cheap. Rising “asset prices” - most of which are held by banks and the wealthy. Phony economic “growth” - official numbers highly dependent on rising prices and rising debt.

Deflation: Decrease in the supply of currency (scarcity of money) along with rising interest rates (the price/cost of money)

Consequences of Deflation:

Falling prices as less (higher value) money chases goods and services. Rising purchasing power to all but the wealthy as income buys more. Higher rates mean increased savings and thereby real capital for productive investment and production. More productive allocation of properly valued capital. More jobs as business expands. A reverse wealth transfer from the banks to the public.

A declining economy and employment picture is NOT the result of deflation as claimed regarding Japan. They are the result of inflationary policies of money printing (inflation tax), suppressed interest rates (destruction and misallocation of capital), burdensome debt loads (rising cost to service), and the expatriation of industry to lower cost and less regulated countries. The effort to protect and sustain failure. Stable or even slightly falling prices in Japan (from very high levels) are more attributed to the surge of cheap Chinese goods replacing higher priced Japanese goods and a relatively strong Yen to the Chinese Yuan and US Dollar – both of whom have been debasing their currencies faster than in Japan.

Another fallacy is the prospect of economic “recovery” via monetary policy. Lowering interest rates and printing money only “stimulates” an economy if that economy has something to work with (an industrial base) in creating value added production and jobs. Otherwise said monetary policy is merely a means for banks to pad their books, hide their losses and speculate in financial markets artificially propping up prices of financial assets and bubbles.

No personality behind this writing. Let the message stand above the messenger – no “credentialed” claims to authority or superior knowledge.